Saturday, December 19, 2009

The Path to Sound Money and a Vibrant Economy

The greatest challenge facing the United States and Western Civilization—which includes all those countries engaged in international trade in order to facilitate social cooperation through the division of labor—is the destruction of money by central banks who have the power to expand their fiat money supply to unlimited proportions. Such fiat money expansion destroys the usefulness of money as a vehicle for communicating value through time and space. What will the dollar be worth in terms of apples and oranges in the future and around the world? No one knows, even when we may predict with a great deal of certainty the quantity of apples and oranges that will be produced in the future and market demand for them. It is not the quantity of apples and oranges that makes future exchange problematic; it is the quantity of money that makes it so.

Because societies have recognized that only a stable quantity of money may perform these crucial services to the economy has money always been a commodity itself with certain characteristics, chiefly among them being its scarcity in nature. For, as Ludwig von Mises has explained, any quantity of money may serve all the functions that are required of money regardless of the size or complexity of the economy. It is the crucial characteristic of scarcity—that is, its quantity—that has been undermined by central banks. Already we have seen the deleterious effects of this debasement of money in the form of repeated and ever more violent boom-bust business cycles. These cycles are the external manifestation of “sick” money; they are NOT the external manifestation of “excessive greed” or any other failing of society’s citizenry. “Sick” money has transmitted its disease to society, not the other way around. Therefore, it is imperative that the United States and other Western nations end the expansion of their money supplies and re-anchor them in some commodity of lasting value, namely gold, silver, or some combination of the two. But…how can this be done? That is the crucial question…the elephant in the living room, so to speak.

Let us first establish that the goal of any currency reform is to end at a stroke the further expansion of the money supply. The expansion of money confers no societal benefit whatsoever. More money does not bring into existence, either in the near term or in the longer term, more goods and services than would be produced without its expansion. The truth of this statement lies in its logic and also in historical experience. But these are subjects for another day. The important point is that ANY further expansion of the money supply causes harm; therefore, it is not a question of gradually reducing the expansion of money. No, we must stop any further expansion by even a very small amount.

First, End Fed and Bank Fiat Money Expansion

In our current fiat money environment, two institutions have the legal ability to expand the supply of money—the Federal Reserve Bank (the U.S. central bank) and commercial banks. Most people understand that the Fed can increase the money supply, but few understand that privately owned banks themselves also have the legal ability to increase the money supply. Although the manner in which money expands can be rather complicated (and needlessly so), I will explain the basics. The Fed can inject money into the economy by monetizing the federal debt; that is, it accepts the government’s promissory notes and credits its checking account. Then the federal government spends the money. This in itself increases the supply of money, as can be easily understood, but there is more. When the recipients of the government’s money deposit their checks, bank reserves increase when the bank of deposit sends the check to the Fed for deposit in its reserve account (a checking account at the Fed that is owned by the commercial, private bank. The Fed is the “bankers’ bank.) Now the banking system has “excess reserves” upon which to pyramid more loans and deposits by a magnitude of from ten times to over one hundred times! All the bank must do is make a loan and credit the loan customer’s checking account. It is restricted in the extent to which it may expand its loans and deposits (in equal amounts) only by the amount of its excess reserves. Remember, the Fed created excess reserves when it monetized the government’s debt. Here lies the danger—under normal conditions banks try to remain completely loaned up, utilizing every penny of their excess reserves by making loans and, in the process, creating money out of thin air. In our large economy, excess reserves normally amount to fewer than two billion dollars, an amount considered to be the frictional amount that cannot be fully utilized. Over the past year the Fed has injected massive reserves into the banking system, and now excess reserves stand at over a TRILLION dollars, or five hundred times the historically normal amount!

The Reisman “First Step” to Neutralizing Excess Reserves

At a Mises Institute Seminar in Long Beach, CA last month, Professor George Reisman presented an intriguing plan to prevent the banks from expanding their lending against this massive amount of excess reserves. He recommended that the Fed create even more reserves! But here’s the twist—the Fed should insert enough reserves of fiat money into the banking system to equal the current level of bank checking accounts, BUT at the same time also require 100% fiat reserves against those checking accounts and prohibit the Fed from creating any more reserves thereafter. This step would do two things. Number one, and most importantly, the banks would not be able to convert those trillion dollars in excess reserves into ten to one hundred trillion dollars of new money. Secondly, it would force the federal government either to tax the people for what it spends or borrow honestly from them. Either method would create a natural limit on government spending, forcing it to prioritize and moderate its plans to those more in line with society’s means.

The Barron “Second Step”--Convert Fiat Money to Commodity Money

Governments cannot be trusted to refrain from violating their own laws. They do so, of course, by passing another law to suspend “temporarily” the previous law which put what it considers to be an undue restraint upon its actions. Therefore, we must return to commodity rather than fiat money. The government could do this by simple arithmetic; it could divide the money supply by the number of ounces of gold it holds to establish a legally binding exchange rate of dollars for gold. Currently the most widely used definition of money—M2—stands at $8.4 trillion, and the government owns 260 million ounces of gold. Therefore, it could provide 100% backing of M2 with gold by agreeing to pay out an ounce of gold for $32,308 and, conversely, to buy gold for the same amount. Presently the price of gold has fluctuated between $1,000 and $1,200 per ounce, so a decision to support the dollar at this dollar-to-gold ratio would have unknown economic consequences. Better for the government to establish the ratio at a level closer to the current market level for non-monetary gold. But how can the government do this? If it prints more money to buy gold in the open market, it would not solve its problem—it would have even more fiat dollars to back by the new quantities of gold it received. But, the government has other resources! The government is like a cash-poor but property rich relative--it owns vast expanses of valuable land. In fact the government owns roughly 30% of the landmass of the United States, mostly in sparsely populated areas west of the Mississippi and in Alaska. This is its ace-in-the-hole.

Selling Government Land for Gold Is Doubly Beneficial!

The government has no just cause for owning more land that its normal day-to-day operations require, such as enough land for its military bases and other government office buildings. Its ownership of lands in the western United States and in Alaska has prevented the development of the resources on these lands for the benefit of the U.S. citizens and the world. Like an anorexic who prefers to starve with nutritious food close at hand, the government refuses to allow the development of valuable resources from its land holdings to feed the resource starved economy of the United States. These lands are potentially the most valuable on the face of the earth. Not only do they hold much mineral and vegetable wealth, but they are located in a capitalist country of entrepreneurs, skilled workers, an honest court system, good infrastructure…in essence, all the factors necessary for successful capitalist development. So, not only would the sale of government land for gold allow for the backing of the U.S. dollar by more ounces of gold and, therefore, ease the transition to a 100% gold standard at a better dollar to gold ratio, it would unleash the productive capacity of 30% of the nation’s land resource! This is not rape of the land any more than a farmer rapes his fertile soil or a timber company rapes its well-managed forests. Selling land allows it to be capitalized and managed for productive benefit into perpetuity, the opposite of government’s so-called management, which is nothing more than locking land away as if it did not exist.

In conclusion, the U.S. can quickly take the necessary steps to return to sound money and at the same time unleash a new, real economic boom. It needs to take steps first to freeze expansion of the money supply, followed by a judicious sale over time of its valuable land holdings for gold. The gold proceeds of the sale would allow the government to back its currency 100% by gold at fewer dollars per ounce. The U.S. would once again have the world’s strongest currency and most productive economy. There is nothing preventing us from taking this action but our own foolish adherence to failed economic theory.

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